7/12/2013 4:45 PM ET|
Managing your 401k as rates rise
While interest rates are bound to rise, no one knows when. And it could well be a year or more before the Fed makes a move. Follow these 7 steps to be ready.
Is it time for 401k savers to abandon bond mutual funds?
Many investors hit the "sell" button on bonds in June -- but if your focus is on retirement, think through your options before you follow the crowd.
The specter of rising interest rates spooked investors into pulling an estimated $60.5 billion out of bond mutual funds last month -- almost a 47% jump from the $41.3 billion withdrawn in October 2008, amid the worst moments of the financial crisis -- according to preliminary data from the Investment Company Institute, a mutual-fund trade group and researcher.
Yields on 10-year Treasurys jumped as high as 2.6% in June, from 1.6% in early May, thanks in part to Federal Reserve Chairman Ben Bernanke's hints about the end of the central bank's bond-buying program, which has pushed interest rates to record lows in recent years. (Bond prices move inversely to yields.)
Some of the biggest bond funds in the 401(k) universe took hits. Pimco'sTotal Return fund (PTTAX) plunged more than 5% from May 1 through July 1 (it's down more than 3% year to date). That fund holds a whopping $79.9 billion worth of 401k assets, according to December 2011 data, the most current available, from researcher BrightScope.
Another big 401k player, Vanguard's Total Bond Market Index fund (VBMFX), dropped about 4% in May and June, and is down more than 2% so far this year. It's enough to make your average 401(k) investor break out in cold sweats.
Here's your first rule: Don't panic. Generally, the best advice for people investing for the long haul -- and your retirement could well last 30 years -- is to pick a suitable asset-allocation strategy, invest in low-cost mutual funds, rebalance regularly and stick with your plan to guard against the all-too-common mistake of buying high and selling low.
Still, following that prudent strategy doesn't mean you should ignore big-picture trends. Rates have been at extraordinary lows since the 2008 crisis. They really have nowhere to go but up, forcing bond values down.
With individual bonds, investors can hold them until their maturity date to retrieve their principal. But most 401k participants have access only to bond mutual funds. As investors flee for the exits, managers may be forced to sell bonds before maturity to honor those redemptions.
Yet, despite the current rate outlook, it doesn't make sense to exit bonds entirely, experts say. One reason: While interest rates are bound to rise, no one knows when. And it could well be a year or more before the Fed makes a move.
"You're essentially timing the bond market just like people try to time the stock market and you've got the same risk: You could be wrong," says Thomas Batterman, a principal at Financial Fiduciaries in Wausau, Wis.
And don't forget why you own bonds: They provide a ballast against stock-market gyrations. "Although one component might come under pressure, it's the other part of the portfolio that you hope is acting as a buffer. That's the beauty of a balanced portfolio," says Catherine Gordon, a principal with the investment strategy group at Vanguard Group.
That said, here are steps 401k investors might consider as they eye the bond-market upheaval:
1. Shift to shorter-term bonds
Generally, long-dated bonds suffer the most as interest rates rise.
A good approximation of risk is that for every percentage point increase in interest rates, your bond fund's value will drop as much as its overall duration ("duration," roughly speaking, is the average maturity of the fund's bond holdings).
If a fund's duration is five years and yields increase two percentage points, the value of the fund will go down by about 10%.
2. Review your target allocation
"For so many years, for so many people, the formula has been 60% equities, 40% bonds," says Bill Harris, chief executive of Personal Capital, an online wealth-management company in Redwood City, Calif. "That's probably not appropriate today."
"It's a very dangerous time to be heavily in long-term bonds," he adds. "We don't think you should be void of long-term bonds and we certainly don't think you should be void of bonds, but shorter durations, lower exposure to bonds than would traditionally be the case."
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"Those choices are not available in most 401k plans, but some employers offer their retirement-plan participants access to a brokerage window, which gives them access to stocks, mutual funds and ETFs via a self-directed brokerage account. Lobby your employer for this option."
Excellent article for printing this. NOBODY ever talks about it.
"As interest rates rise, your bond fund will be buying higher-yielding issues. That's good news for people with a long-term outlook."
Bingo. Most bond investors who fear falling prices overlook the benefit of being able to reinvest their yields in lower cost bonds. Over the long haul, you always end up better off with higher rates, even if you take an initial hit from falling prices. That’s the hidden dirty little secret of the Fed’s ZIRP policy; it forces investors to reinvest their earnings at falsely inflated asset prices.
Buy short term non callable corporate bonds and hold to maturity.Williams companys 10.250 coupon
maturity july 15 2020 price 105.00 yield to maturity 9.61 not callable.
V_L is right on. The Vanguard options in 401 k's are losing money. Ice, most employers's have this "option" readily available and choose not to. They do not want to contribute period, and do not. Over 50 enployees...you might see a 25% contributions, when vested, and that normally is 5 years, now. Key employees with be "vested immediatley" especially in closely held corps and holding companies which is much the same. You have to know how it works. The "partners" are much the same in this with both. Also, you need to know 401'ks and how they work. It does not accelerate they way the pundits want you to believe with "markets". The "markets" are a scam, period.
How to manage your 401K as rates rise...
Quit your job, take your 401K and put it in a rollover IRA, leverage it to build your enterprise and be a self-employed person. Wage earners will be devastated as we wean ourselves off QE. You'll be like sitting ducks.
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